Macroeconomics

The financial markets have only had one major piece of news to digest during the past two weeks. This was the shocking news last Thursday that a large investment holding in Dubai has asked to delay repayments of its outstanding debts for at least six months. 

The way the financial markets reacted to the story was interesting, and it was also interesting to see how much the last year has changed fear and alert levels. Think how the same news would have hit the markets before the Lehman Brothers crash.

The markets were affected for just a day. Within a short time the financial markets were busy explaining that the level of debt ($60 billion) is not really significant and would not really harm the financial system.

Although this might be true it was another demonstration of ignorance. Knowing that a number of banks involved in financing the ‘sand castles’ are already living on government support and tax payers’ money it is amazing to see how the industry was trying to sweep the problems under the carpet. It seems we have finally lost any concept of money and amounts, no matter how critical it could turn out to be. 

The rest of the financial news continued to be based more on hope than on facts. On one side European credit insurers are expecting record bankruptcy levels in 2010, banks are still not willing to lend enough money to businesses because they have (justified) concerns that the loans cannot be repaid. On the other side, business polls about the economic outlook in various EU countries are still pretty optimistic.

This is another proof of the rule that you get what you ask for when you ask the right people the right questions. How a company that is threatened by insolvency and cannot obtain the finance it needs can have a positive business outlook is a good question. Anyway, from a psychological point of view any positive news is appreciated, but it also presents the risk that companies and those who are losing their jobs could get the impression that some are thriving at their expense.

In the meantime, the financial markets are not acting according to their own opinions. With all the optimism for a recovery in 2010, production-related commodities are taking a break in their price ascents. Oil, metals and so on are either just flat or have even declined in the past weeks, while investment in risk-protective commodities (gold) continues to hit record levels. This means that investors and national banks are seeing big risks ahead and would rather protect their positions through value investments.  

The US$ continues to be weak against most of its rivals and the conflict between the political statements and realities is ongoing.

Market intelligence

As has sometimes happened in the history of the Market Intelligence report, we could have copied the last edition into this one and there would have been no conflict. The situation is pretty much the same as it was two weeks ago. Consequently, it is pretty difficult to deliver a great deal of new information and facts that could influence the state of the market.

We were expecting demand from tanners to start to fade and that suppliers would get a bit less comfortable about sales and the outlook for 2010. This year is starting to wind down now; in Europe most tanneries stop their soakings around December 20 at the latest, while some cease operations in their beamhouses some days before this. Many tanneries try to secure raw material by using either contract tanners or asking their suppliers to salt the material and keep it until they reopen.

Demand for high-quality material continues

Under normal conditions this would have some effect on the market because many suppliers in Europe do not fancy salting material as they are afraid buyers will not be willing to accept the material later on in a salted state. However, since the beginning of 2009, when a lot of tanneries overseas, particularly in Asia, started to try and use top-quality European material, many suppliers have found potential alternatives for this material, which has traditionally been an ‘EU-only’ product.

However, this might not be the only reason suppliers aren’t concerned about the market and possible stocks building over the Christmas season. With the ongoing demand and business since November, many of the quality suppliers are well sold forward and are running pretty low stocks. So they actually don't really mind if a few hides start to pile up as this would allow them to return to some kind of emergency inventory that can be used during the weeks when slaughter in the abattoirs does not reach the normal and expected levels.

Having said this, we should also mention that we are hearing week by week about cheap offers circulating, and astounding quantities that are said to be available for reasonably prompt shipments. When we tried to verify this information with either abattoir groups or the better names in the processing industry around Europe, we found very few who actually believe that this can be regular, quality material.

This may also be the opinion of potential buyers, because speaking to a number of the top tanners in China some are confirming that they have these kinds of offers on their desks, but they are not considering them as they have had pretty bad experiences with these suppliers in the past. This also confirms that tanners today are still pretty much focused on securing better material.

Other markets are showing a similar pattern. Most big packers and good-quality suppliers are also enjoying reasonable forward positions and are feeling pretty comfortable about the market future. There are still enough buyers around; the few offers that are made are always picked up each week. This is the case in the US, but also in Australia and South America.

What the prices mean

The discussion within the established forces and the leather pipeline pundits continues to be whether the present market prices are a realistic reflection of the situation, whether the market has just been pushed by cheap money or speculation, or whether leather demand globally has recovered so much that the present price levels are unjustified and are the reply to an exaggerated depression following the financial crisis. It is pretty difficult to find the right answer.

Those who had the courage to buy large volumes of raw material during the first half of 2009 have had a good year and will have generated enough profit and cash to continue to replenish their inventories on a constant basis. Raw material prices dropped by 50-70% during the last quarter of 2008, while leather prices, at least for those who had sufficient orders, have possibly only dropped by 20-30%.

This has offered a nice margin for those players. However, from all the information and statistics we can obtain, it is hard to believe that leather consumption in 2009 has been the same as it was in 2008. If these assumptions are correct, one has to expect stocks somewhere along the pipeline. The stocks will definitely not be raw material or better-quality semi-finished or finished leathers. This brings us back to the discussion about how there could be large low-grade material stocks somewhere around the globe.

No matter whether they exist or not, those producers holding them will probably not be too bothered, because the present value of raw materials makes them look pretty cheap, so nobody is really desperate to offload them. In addition, many of the owners are likely to be winners of the raw material speculation and will still be able to access sufficient resources to finance inventory. This is a classic foundation for the firm market conditions and might explain the present situation with which we are dealing.

Conflicting views

The market optimists for 2010, and these are mainly the producers of hides, are using the present conditions to paint a pretty rosy picture for the year to come. They are also mentioning that hide prices, in their opinion, are still not on historically high levels and are simply back to being what could be called the upper end of the average. In non-US$ regions, this situation might be a bit different, because the weak US$ is controlling high price levels in local currencies much more.

Pessimists and the more cautious members of the trade are displaying rising concerns. Their main argument is the level of leather consumption within the current global economic climate, and they are adding that the way the market has risen for about nine months in a row cannot be digested without any price setback. They also claim the cost averaging effect that has been used for most of 2009 is slowly but surely losing its influence and raw material prices are too high for the leather prices, which came down during the last season.

Also taking rising energy costs into consideration, today's calculations for a tanner on the basis of actual raw material cost can hardly be profitable. By consequence, they are seeing tanners’ resistance to higher raw material costs constantly growing and, with the start of the new season after the Asian New Year holidays, they are anticipating that lower raw material demand and more pressure for sellers will be the market scenario during the first quarter of 2010.

It seems both parties have good arguments to back up their positions. A lot will definitely depend on the outlook for the global economy further into 2010. Many feel that the recovery was generally connected with the cheap money policy of the national banks. This is not going to be sustainable and rising unemployment will eventually result in a decline in personal consumption. China is the rising force in compensating for the problems in the Western world but could also face problems if its economy is actually built on a bubble, which could potentially burst one day.

Splits and skins

The splits market has not delivered much news that could offer additional insight into the market trends. The situation remains reasonably directionless and prices are hardly moving. 

The skins market is very much influenced by the strong demand for Merino-type skins. Sheepskin boots remain in fashion in many parts of the world and there are simply not enough raw materials available to satisfy the orders that are circulating. With sharp gains in prices and a lack of raw material in the southern hemisphere, many Chinese tanners are currently investigating other origins and are pretty surprised not to find too many skins to solve their problems. There are still quite a number of cheap stocks around in Europe and a lot of potential buyers are travelling at the moment to find out whether any of this material could suit their needs. They are all finding themselves disappointed. The nappa business is still good for shoe leathers, but garment leathers are still not really taking off.

Over the coming weeks we expect the business to continue to wind down. Many in the leather pipeline are happy to see that an extremely difficult year is coming to an end and that they will have the chance to take a break and rest for a moment before the no less challenging 2010 begins. Next year is definitely going to be even more problematic because of the high raw material costs and shrinking margins. More financial resources will be required and this is pretty challenging these days, in Europe and the US at least. Banks are not really willing to offer more credit and certainly not if it is being used to finance higher raw material prices with a pretty uncertain outlook as to whether productions can be run profitably.

Although the Chinese leather industry is the major factor in terms of cash-flow, profits could become the determining factor into 2010 and will also, in our view, have some dampening influence on market conditions. It is hard to believe that the markets will see major fluctuations in the coming weeks. Nobody is really interested in seeing prices change much before the end of the calendar year and with hardly any stocks pressing sellers to lower prices, and very few desperate to buy it seems the present levels could possibly be similar to those we should expect toward December 31.

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